UNIT 3: AUDITING PRINCIPLES AND TOOLS

3.0 AIMS AND OBJECTIVE

When you have studied this unit you should be able to:
 be aware of basic auditing principles.
 be aware of planning issues for an audit.
 state the typical contents of working papers.
 describe sampling as applied to auditing.

3.1 INTRODUCTION

The objectives of each audit must be clearly specified in order to ensure appropriate goal
achievement. Appropriate auditing principles and standards should be developed by auditors to
direct the objectives.

Audit planning is a vital area of the audit which is primarily conducted at the beginning of the
audit process.
This unit also considers the basic contents of audit working papers and audit sampling.

3.2 AUDIT OBJECTIVES

The objective of the ordinary examination of financial statements by the auditor is expression of
an opinion on the fairness of the financial statements. It is customary in the audit to identify
audit objectives for the audit in general and for each account reported in the financial statements.
These objectives are derived from management’s assertions.

The auditor’s objectives are closely related to management assertions. Audit objectives are
intended to provide a framework to help the auditor accumulate sufficient and competent
evidence required by the third standard of fieldwork and decide the proper evidence to
accumulate given the circumstances of the engagement.

A distinction must be made between general audit objectives and specific audit objectives for
each account balance. The general audit objectives discussed here are applicable to every

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account balance but stated in broad terms. Specific audit objectives are applied to each account
balance on the financial statement.

The relevance of the audit evidence should be considered in relation to the general audit
objectives of statements. To achieve this objective the auditor needs to support the following
financial statement assertions (i.e. assertions by management embodied in the financial
statements).
1. Existence: - an asset or liability exists at a given date. Auditors
spend a great deal of time on this assertion confirming the existence of assets such as
inventories, plant assets, receivable, and cash. Clearly this is a fundamental assertion; no
other assertion is relevant if the asset or liability does not exist.
2. Completeness: - there are no unrecorded assets or liabilities,
transaction or events.
3. Occurrence: - a transaction or event occurred during the relevant
accounting period (i.e. has correct cut-off been applied?).
4. Measurement: - a transaction or event is recorded at the proper
amount and in the correct period.
5. Ownership: - an asset pertains (i.e. belongs) to the entity.
6. Valuation: - the asset or liability is recorded at an appropriate
carrying value.
7. Presentation and disclosure: - must be in accordance with the
relevant legislation and accounting standards (i.e. the applicable financial reporting
framework). E.g.
 Is n/r with 5 years maturity presented under investment?
 Is land held for sale purpose presented under investment section?
 Is gain from sale of fixed asset presented under other income?

After the general objectives are understood, specific objectives for each account balance on the
financial statements can be developed.

Check Your Progress Exercise-1

1. What are assertions and what are the seven classifications of assertions?

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3.3 AUDITING PRINCIPLES

Auditing principles are generally, guidelines that help direct or chart goals and aims. Principles
are based on concepts or assumptions, and/or developed from particular observations. The
following are the basic principles:

(a) Integrity, objectivity and independence.

independence. The auditor should be straightforward,
honest, and sincere in his approach to his professional work.
(b) Confidentiality: - the audit should respect the confidentiality of information acquired in
the course of his work and should not disclose any such information to a third party
without specific authority unless there is legal or professional duty to disclose.
(c) Skills and competence: - the audit should be performed and the reports prepared with
due professional care by persons who have adequate training, experience and
competence in auditing.
(d) Documentation: - the auditor should document matters which are important in providing
evidence that the auditor was carried out with the basic principles.
(e) Planning: - the auditor should plan his work to enable him to conduct an effective audit
in efficient and timely manner.
(f) Audit evidence: - the auditor should obtain sufficient appropriate audit evidence through
the performance of compliance and substantive procedures to enable him to draw
conclusion there from and give opinion on the financial statements.
(g) Accounting system and internal control: The auditor should gain or understanding of
the accounting system and related internal controls to determine the nature, extent, and
timing of audit procedures.

3.4 AUDIT STANDARDS

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Standards are authoritative rules for measuring the quality of performance. The existence of
generally accepted auditing standards is evidence that auditors are very concerned with the
maintenance of a uniformly high quality of audit work by all independent public accountants.
The 10 GAAS are stated in their entirety as follows:

General standards
1. The examination is to be performed by a person or persons having adequate
technical training and proficiency as auditor.
2. In all matters relating to the assignment, an independence in mental attitude is to
be maintained by the auditor or auditors.
3. Due professional care is to be exercised in the performance of the examination
and the preparation of the report.

Standards of fieldwork
1. The work is to be adequately planned and assistants, if any, are to be properly
supervised.
2. The auditor should obtain a sufficient understanding of the internal control
structure to plan the audit and to determine the nature, extent and timing of tests to be
performed.
3. Sufficient competent evidential matter is to be obtained through inspection,
observation, inquiries, and confirmation to afford a reasonable basis for an opinion regarding
the financial statements under examination.

Standards of reporting
1. The report shall state whether the financial statements are presented in accordance
with generally accepted accounting principles.
2. The report shall identify those circumstances in which such principles have not
been consistently observed in the current period in relation to the preceding period.
3. Informative disclosures in the financial statements are to be regarded as
reasonably adequate unless otherwise stated in the report.
4. The report shall either contain an expression of opinion regarding the financial
statements, taken as a whole, or an assertion to the effect than an opinion cannot be
expressed.

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Keep in mind, however, that these standards represent the minimum requirements for all audit
engagements.

Check Your Progress Exercise -2

What three categories are GAAS divided into?
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3.5 AUDIT PLANNING AND AUDIT PROGRAM

The first standard of fieldwork states:

“The work is to be adequately planned, and assistants, if any, are to be properly supervised.”
The concept of adequate planning includes investigating a prospective client before deciding
whether to accept the engagement, obtaining an understanding of the client’s business
operations, and developing an overall strategy to organize, coordinate, and schedule the activities
of the audit staff.

In planning the audit the auditor needs to consider the following:

1. The terms of the engagement and the expected date of the report.
2. The nature of the client’s business.
3. The experience gained during previous audit engagements.
4. The accounting policies and degree of complexity of the accounting system.
5. Materiality and the components of audit risk.
6. Any involvement of other auditor.
7. Any involvement of internal auditors and persons having special expertise.
8. The intended reliance on internal control.
9. The level of experience and the number of audit staff for the engagement.
10. The timing and effectiveness of performing of the audit procedures.

(a) Client acceptance

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The auditors should investigate the history of the prospective client, including such matters as
the identities and reputations of the directors, officers, and major shareholders, its financial
statements and audit report.

Sources of information
 Communication with predecessor auditors.
 Make enquiries of other third parties (e.g. banker.).
 Consult the client’s legal counselor.

(b) Obtaining the engagement

After the auditors have collected the necessary information on the potential client, they will be in
a position to assess the various risk involved with the audit and determine whether to attempt to
obtain the engagement. Often they will be asked to submit a proposal which will include
information on the nature of services that the firm will offer, the qualification of the firm’s
personnel, and other information to convince the prospective client to select the firm.

Fee arrangement: when the business engages the services of independent public accountant, it
will usually ask for an estimate of the cost of the audit.

Engagement letter: The preliminary understandings with the client should be summarized by the
auditors in an engagement letter, making clear the nature of the engagement, any limitations on
the scope of the audit, work to be performed by the client’s staff, schedule dates for performance
and completion of examination, and the basis for computing the auditors’ fee.

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(c) Obtaining an understanding of the client’s business.
After the engagement is accepted, the auditors must obtain a detailed understanding of such
factors as the client’s financial position and operating results, organization structure, product
lines, and methods of production and distribution. This will help auditors to evaluate the
appropriateness of the accounting principles in use or the reasonableness of the many estimates
and assumptions embodied in the client’s financial statements.

(d) Developing an overall audit strategy

After obtaining knowledge of the client’s business, the auditor should formulate an overall audit
strategy for the upcoming engagement. The best audit strategy is the approach that results in the
most efficient audit.
In planning an audit, the auditors must consider carefully the appropriate levels of materiality
and audit risk.

Materiality: In planning the audit, auditors should design their audit procedures to avoid wasting
time searching for immaterial misstatements that cannot affect their report.

Audit risk: The term audit risk refers to the possibility that the auditors may unknowingly fail to
appropriately modify their opinion on financial statements that are materially misstated.
In developing an audit plan, the auditors must consider factors that affect audit risk.

(e) Audit plans

The planning process is documented in the audit working papers through the presentation of
audit plans, audit programs, and time budget. An audit plan is an overview of the engagement,
outlining the nature and characteristics of the client’s business operations and the overall audit
strategy. A typical audit plan includes the following:

1. Description of the client’s company-its structure, nature of business, &

organization.
2. Objectives of the audit.
3. Nature and of extent of other services.
4. Timing and scheduling of audit work.
5. Work to be done by the client’s staff.

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 6. Staffing requirement during the engagement.
7. Target dates for completing major segments of the engagement.
8. Preliminary judgment about materiality and risk levels for the engagement.

(f) Designing audit programs

An audit program is a detailed list of audit procedures to be performed in the course of the
examination. An audit program is designed to accomplish certain objectives with respect to each
major account in the financial statements. These objectives follow directly from the assertions
that are contained in the client’s financial statements.

3.6 AUDIT WORKING PAPERS

Working papers are records kept by the auditor of the procedures applied, the test performed, the
information obtained, and the pertinent conclusions reached in the audit. For example, when
samples are taken for audit tests, the items drawn must be recorded and computations must be
made.

Working papers provide:

 The principal support for the auditor’s report.
 A means for coordinating and supervising the audit, and.
 Evidence that the audit was made in accordance with GAAS.

Working papers normally include the audit plan and programs, documentation of the auditor’s
understanding of the internal control structure, the assessed level of control risk, account
analyses explaining the composition of account balances, reconciliation of related records, letters
of confirmation and representation, recommended journal entries if necessary to correct the
accounts, and trial balances and other schedules that summarize the contents of other working
papers.

3.7 AUDIT SAMPLING

1. Definition: Application of audit procedures to less than 100 % of the items within
an account balance or class of transactions to obtain and evaluate audit evidence about some

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 characteristic of the items selected in order to form or assist in forming a conclusion
concerning the population.

Sampling risk
Because the auditor dose not examine all the items in the population when applying audit
sampling, there is a risk that the conclusion that he draws will be different from that which he
would have drawn had he examined the entire population. This is ‘sampling risk’.
The following are the basic factors affecting sample size:
 Population size.
 Materiality.
 Reliability.

Statistical and non-statistical sampling

Statistical sampling involves the use of mathematical procedures, such as probability theory to
draw conclusions reached about the population. Non-statistical sampling techniques rely on the
auditors’ judgment to draw conclusions.

2. Constructing sampling.
The steps involved in sampling can be summarized as follows:
o Sample design: - when designing an audit sample, the auditor should consider the
specific audit objectives, the population from which the auditor wishes to sample, and the
sample size.
o Selection of the sample: - the auditor should select sample items in such a way
that the sample clan be expected to be representative of the population.
o Evaluation of the sample: - having carried out, on each sample item; those audit
procedures that are appropriate to the particular audit objective, the auditor should:
(a) Analyze any errors detected in the sample.
(b) Project the errors found in the sample to the population, and
(c) Reassess the sampling risk.

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